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We explore whether lenders’ decisions to provide liquidity in periods of distress are affected by the extent to which they internalize the negative spillovers of industry downturns. We conjecture that high-market-share lenders are more likely to internalize negative spillovers and show that they provide liquidity to industries in distress when fire sales are likely to ensue. High-market-share lenders also provide liquidity to customers and suppliers of distressed industries when the disruption of supply chains is expected to be costly. Our results suggest a novel channel to explain why credit concentration may favor financial stability.

This article examines the international determinants of capital structure using a large sample of firms from 37 countries. The reliable determinants for leverage are firm size, tangibility, industry leverage, profits, and inflation. The quality of the countries’ institutions affects leverage and the adjustment speed toward target leverage in significant ways. High-quality institutions lead to faster leverage adjustments, whereas laws and traditions that safeguard debt holders relative to stockholders (e.g., more effective bankruptcy procedures and stronger creditor protection) lead to higher leverage.

This paper studies how the conflict of interest between shareholders and creditors affects corporate payout policy. Using mergers between lenders and equity holders of the same firm as shocks to the shareholder-creditor conflict, I find that firms pay out less when there is less conflict between shareholders and creditors, suggesting that the shareholder-creditor conflict induces firms to pay out more at the expense of creditors. The effect is stronger for firms in financial distress.

We examine the effect of financial reporting quality on the trade-off between monitoring mechanisms used by lenders. We rely on Sarbanes-Oxley internal control reports to measure financial reporting quality. We find that when a firm experiences a material internal control weakness, lenders decrease their use of financial covenants and financial-ratio-based performance pricing provisions and substitute them with alternatives, such as price and security protections and credit-rating-based performance pricing provisions. We also find that changes in debt contract design following internal control weaknesses are substantially different from those following restatements, where lenders impose tighter monitoring on managers' actions, but do not decrease their use of financial statement numbers.

The empty creditor problem arises when a debtholder has obtained insurance against default but otherwise retains control rights in and outside bankruptcy. We analyze this problem from an ex ante and ex post perspective in a formal model of debt with limited commitment, by comparing contracting outcomes with and without insurance through credit default swaps (CDS). We show that CDS, and the empty creditors they give rise to, have important ex ante commitment benefits: By strengthening creditors' bargaining power, they raise the debtor's pledgeable income and help reduce the incidence of strategic default. However, we also show that lenders will over-insure in equilibrium, giving rise to an inefficiently high incidence of costly bankruptcy. We discuss a number of remedies that have been proposed to overcome the inefficiency resulting from excess insurance.

In this paper, I examine the effect of credit default swaps (CDSs) on the restructuring of distressed firms. Using a sample of U.S. distressed exchange offers during the period 2006–2011, I show that the participation rate among bondholders is significantly lower if the firm has CDSs traded on its debt. To address endogeneity concerns, I use the introduction of the Big Bang Protocol as a natural experiment. The results suggest that firms with CDSs find it difficult to reduce debt out of court. This is important because it can increase the likelihood of future bankruptcy, which is inefficient. The findings are consistent with the empty creditor hypothesis, which posits that bondholders who are hedged with CDSs are less likely to participate in a debt restructuring. The paper also contains direct evidence for the existence of empty creditors. This paper was accepted by Amit Seru, finance .

Standard credit risk models cannot explain the observed clustering of default, sometimes described as \"credit contagion.\" This paper provides the first empirical analysis of credit contagion via direct counterparty effects. We find that bankruptcy announcements cause negative abnormal equity returns and increases in CDS spreads for creditors. In addition, creditors with large exposures are more likely to suffer from financial distress later. This suggests that counterparty risk is a potential additional channel of credit contagion. Indeed, the fear of counterparty defaults among financial institutions explains the sudden worsening of the credit crisis after the Lehman bankruptcy in September 2008.

We establish that creditor beliefs regarding future borrowing can be self-fulfilling, leading to multiple equilibria with markedly different debt accumulation patterns. We characterize such indeterminacy in the Eaton-Gersovitz sovereign debt model augmented with long maturity bonds. Two necessary conditions for the multiplicity are (i) the government is more impatient than foreign creditors, and (ii) there are deadweight losses from default. The multiplicity is dynamic and stems from the self-fulfilling beliefs of how future creditors will price bonds; long maturity bonds are therefore a crucial component of the multiplicity. We introduce a third party with deep pockets to discuss the policy implications of this source of multiplicity and identify the potentially perverse consequences of traditional “lender of last resort” policies.

To mitigate holdup by an informed incumbent lender, a private borrower may publicly share information in order to increase lender competition. Despite proprietary costs, a subset of private borrowers voluntarily share private information in loan and credit underwriting agreements. These borrowers switch lenders at a 16% higher rate and receive lower loan financing costs. For private firms that go public, we analyze changes in the net benefits of information sharing and study the potential estimation bias from unobservable borrower quality. This setting corroborates our inference that voluntary information sharing reduces lender holdup and alleviates financial constraints for private firms.

We investigate the effect of shareholder activism on debtholders by examining a sample of bank loans for firms targeted by activist hedge funds. We compare loan spreads before and after intervention and show the effects of heterogeneous shareholder actions. Spreads increase when shareholder activism relies on the market for corporate control or financial restructuring. In contrast, spreads decrease when activists address managerial entrenchment. Furthermore, the effects are more pronounced when pre-existing governance mechanisms are weak. Our findings suggest that shareholder activism does not necessarily exacerbate bondholder-shareholder conflicts of interest and highlight the role of activism in aligning investors.